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What Is a Stablecoin? Types and How They Work

Stable in name, but not always stable in practice β€” here's what a stablecoin actually is, and why a peg can break.

What a stablecoin is

Unlike a typical cryptocurrency such as Bitcoin, whose price can swing wildly, a stablecoin is designed to peg its value to a fiat currency like the US dollar or another asset, keeping price volatility to a minimum.

Fiat-collateralized stablecoins

The issuer holds real currency, like US dollars, or equivalent low-risk assets as reserves, and issues coins backed one-to-one (or close to it) by those reserves.

Crypto-collateralized stablecoins

Instead of fiat currency, these stablecoins are backed by other cryptocurrencies posted as collateral, typically over-collateralized so the coin issued is worth less than the collateral backing it.

Algorithmic stablecoins and the TerraUSD/LUNA collapse

Algorithmic stablecoins try to hold their peg purely through an algorithm and a mint-and-burn mechanism between two linked tokens, without any real collateral behind them. The 2022 collapse of TerraUSD (UST) and LUNA is the best-known failure of this model, where the peg broke and the coin's value evaporated within days.

Why pegs break

When market confidence shakes and a wave of redemptions hits all at once, a stablecoin's peg can break temporarily, even with adequate reserves or collateral, simply because converting everything to cash fast enough is difficult.

What to check before using or investing in one

Before using or holding any stablecoin, it's worth checking what kind of collateral model it uses and whether its reserves or collateral are regularly verified through audits and disclosed transparently.

Why people actually use stablecoins

Because their price is relatively stable, stablecoins are widely used as the base currency for trading other cryptocurrencies on exchanges, and as a tool for cross-border payments and remittances, where converting in and out of volatile crypto each time would be impractical.

Not a bank deposit, and regulation is still evolving

This page introduces the general concepts and structures behind stablecoins for educational purposes and isn't a recommendation to use or invest in any specific coin or service. Rules around stablecoins vary by country and are still being actively developed, so check the latest terms of the exchange or service you use, along with your local financial regulator's guidance.

Frequently Asked Questions

Is a stablecoin as safe as a bank deposit?

No. Stablecoins aren't covered by deposit insurance, and their value can be lost depending on the collateral structure and the issuer's trustworthiness. As TerraUSD/LUNA showed, a coin relying purely on an algorithm with no real collateral can see its peg collapse entirely, so the risk profile is fundamentally different from a bank deposit.

Does being collateralized automatically make a stablecoin safe?

Collateralized stablecoins are generally seen as more stable than algorithmic ones, but how safe they actually are depends heavily on whether reserves are genuinely sufficient and whether they're disclosed transparently and audited. Rather than assuming safety just because a coin is labeled 'collateralized,' it's worth checking its actual reserve disclosures.